Does financial crisis change the relationship between bank development and economic growth? Evidence from US states

by Fang Li, Sheng Zhang

This paper investigates the causal relationship between bank development and economic growth in the US before and after the financial crisis in 2008. Based on the quarterly panel data of US states for 2002Q1-2012Q4, this paper uses two-step system GMM method to test the long-term and short-term impact of bank on growth. In addition, panel Granger causality test is used to verify the causality between bank and growth in different periods. The study finds that banks have played a significant role in the long-run economic growth process and there exists a bidirectional causality between bank and growth among US states. In the short term, the financial crisis has corrected the short-run relationship between bank and growth. The relationship between bank and growth has changed from one-way causality before the crisis to two-way causality after the crisis. Before the crisis, economic growth promotes bank credit, but bank development does not promote growth. After the crisis, banks play the role of economic driver through credit, savings and services, and economic growth drives bank savings and scale expansion. The financial intermediary service functions of banks, especially credit to private sector and absorbing savings to transfer loans, determine the role of bank development in economic growth. Policy makers should support bank development in the long run to establish a mature financial intermediary system and promote regional economic development.